The term sheet arrives with an appealing rate and an offer that feels like relief. Then the full package comes: a commitment letter, a promissory note, a general security agreement, a personal guarantee, a landlord waiver, an assignment of insurance. Most owners flip to the signature tabs, because the bakery’s new oven is on order or the trucking company’s payroll is due next Friday.
Those documents, though, decide what happens on the worst day of your business’s life. They determine what the lender can take, how fast it can act, and whether your house is exposed. It is far easier to negotiate them before the money moves. After signing, you are generally asking for a favour.
This article provides general information and not legal advice about any particular loan. Terms vary widely among lenders, and specific advice should be based on your actual documents and on your financial position.
Read the Commitment Letter Like a Contract
The commitment letter or term sheet is often treated as a summary, but it may be binding and may commit you to fees whether or not the loan closes. Read it for:
- The amount, the purpose, and any restrictions on how funds can be used
- The interest rate, and whether it floats with prime
- Fees: commitment, renewal, administration, and legal costs, which are often charged to the borrower regardless of outcome
- Repayment schedule, and whether there is a penalty for paying early
- Conditions that must be satisfied before funds are advanced
- Whether the loan is a term loan or a demand facility
That last point is often overlooked. A demand loan can be called at any time, even when you have made every payment on schedule, although lenders must generally allow a reasonable time to pay. A monthly payment schedule attached to a demand loan does not change its fundamental nature. Term loans give more stability but usually have more detailed covenants.
Interest rules also apply. The Interest Act requires a rate expressed for less than a year to show its annual equivalent, and the Criminal Code caps interest for many borrowers. The criminal rate is 35 per cent APR. Regulations apply a different limit to commercial loans made to corporate borrowers: above $10,000 and up to $500,000, the ceiling is 48 per cent APR, and above $500,000 no criminal limit applies. Loans to individuals, including sole proprietors, are treated differently from loans to corporations. This matters because alternative lenders’ fees can drive the true annual cost far above the stated rate, so ask for the full calculation when borrowing from a non-bank lender.
Covenants: The Rules You Live With
Covenants are ongoing promises that continue for the life of the loan. They can catch an otherwise healthy business, because breaching one can be an event of default even when every payment is on time.
Positive covenants require you to do things, such as delivering annual financial statements within a set time, maintaining insurance, and paying taxes and source deductions. Negative covenants prohibit things without the lender’s consent, such as borrowing elsewhere, granting other security, selling major assets, paying dividends above a limit, changing control, or moving locations.
Financial covenants set numeric tests, often a debt service coverage ratio or a limit on debt to tangible net worth. Ask your accountant to model these against a realistic bad year, not your optimistic projections. Also check how they are calculated, particularly in a seasonal business, or one that depends on a few large customers.
If a covenant looks unworkable, raise it before you sign. Asking for a higher threshold, a longer delivery period, or a cure right is routine, and lenders tend to negotiate more readily when the deal is still in front of them.
What a General Security Agreement Actually Covers
A general security agreement, usually called a GSA, gives the lender a security interest in essentially everything the business owns now or acquires later, apart from real estate. That normally includes equipment and vehicles, inventory, accounts receivable, intangibles such as intellectual property, and proceeds from any of these.
Ontario’s Personal Property Security Act (PPSA) governs these interests. The Act applies to any transaction that in substance creates a security interest, whatever it is called, so conditional sales, many equipment leases, and floating charges can all fall within it. Land is handled separately through a charge registered on title.
A few practical effects follow. Your inventory can usually be sold in the ordinary course, but selling a major machine or a truck outside the ordinary course may require lender consent. Equipment you buy next year is likely caught automatically, as is the money your customers owe you. And your lender may have a say in whether another lender can finance anything, unless you carve out specific items in advance.
Banks may also take security under section 427 of the Bank Act over certain types of property, and that security operates under its own federal rules.
Attachment, Perfection, and Priority
These words are the core of PPSA law, and they explain most of what you see happening during a closing.
A security interest attaches when value is given, the debtor has rights in the collateral, and the debtor has signed a security agreement describing the collateral, in the usual case where the lender does not take possession. Attachment makes the interest enforceable against you.
Perfection protects it against other parties, and it usually happens by registering a financing statement in Ontario’s Personal Property Registry. Registration can run for a set number of years or indefinitely, which is why old registrations can linger.
Priority between competing lenders is, broadly, determined by the order of registration or perfection, subject to a number of exceptions. The most important exception is the purchase-money security interest, which gives a lender or seller who financed the purchase of a specific asset priority over an earlier general lender. For equipment, it needs to be perfected before or within 15 days after the debtor gets possession. Inventory has a stricter rule: registration must be in place before the debtor gets possession, and earlier secured parties must be notified.
For borrowers, the upshot is that an equipment dealer’s financing can coexist with your bank’s GSA, but only if everything is done properly. Run a search on your own company before you apply. It is common to discover forgotten registrations from a lender who was paid off years ago. Under the PPSA, once the debt is repaid, you may demand that the secured party register a discharge. Clearing this up ahead of time can avoid a closing delay. Verify your corporation’s exact legal name in those registrations too, since name errors can create problems for lenders and later buyers.
The Personal Guarantee
Incorporation shields owners from a company’s debts until they sign a personal guarantee, and most small business lenders will ask for one. Once you have signed, the shield is gone for that debt. The lender may be able to pursue your savings, your investments, and your interest in your home. It generally need not exhaust its claims against the business first.
Before signing, look closely at these features:
- Limited or unlimited: a guarantee can be capped at a set amount, or even reduced over time as the loan is paid
- Scope: does it cover only this loan, or all current and future debts of the company?
- Joint and several: if there are several guarantors, can the lender collect it all from one of them?
- Waivers: a guarantee usually gives up rights you would otherwise have if the lender changes the deal
- Spousal guarantees: can a spouse who has no role in the business be left out?
Lenders often insist that a guarantor receive independent legal advice, particularly if that person does not benefit directly. A guarantor should take this seriously, because such a signature could put a family home at risk for a business that person does not control.
Government-backed lending may offer different terms. The federal Canada Small Business Financing Program shares losses with participating lenders on qualifying loans to small businesses, and under its rules a personal guarantee must be unsecured and limited to the original loan amount. The program has limits on revenue, loan size, and permitted uses, and it charges fees, so check the current rules with your bank or the program itself.
Other Documents You May See
Landlord waiver or postponement. Commercial landlords have rights to distrain for rent over goods on the premises. A lender may want your landlord’s agreement to subordinate those rights, which can hold up a closing if your landlord is slow or uncooperative. Raise this early.
Assignment of insurance and material contracts. Your lender becomes a loss payee so it gets paid first from an insurance claim. It may also take an assignment of major contracts or receivables.
Postponement of shareholder loans. Owners who have lent money to their own company are usually asked to agree to be repaid only after the lender is. Check the effect on your personal plans.
Corporate resolutions and legal opinion. The lender wants evidence that the company actually authorized the loan. An outdated minute book or an unclear share register may become an obstacle at the last minute, so get those in order before applying. Keep in mind that a shareholder agreement may also require other owners to consent.
What Happens on Default
Defaults range from a missed payment to the sale of an asset without permission to a bad financial ratio. Many agreements also include a “material adverse change” clause, giving the lender room to act when it believes your situation has worsened. Check whether you have any notice and cure periods.
Enforcement generally proceeds in stages, and the law imposes some brakes:
- A demand for payment, with a reasonable time to pay
- A notice of intention to enforce security under section 244 of the federal Bankruptcy and Insolvency Act, if the lender intends to enforce against all or substantially all of the inventory, receivables, or other property of an insolvent business. The lender generally cannot enforce until 10 days after sending it, unless the debtor consents to earlier enforcement
- Appointment of a receiver, privately or through the court, or seizure and sale of the collateral
- Notice of disposition under the PPSA, ordinarily at least 15 days before a sale, to the debtor and others with an interest in the collateral
- A commercially reasonable sale, with proceeds applied to costs, then the secured debt, then subordinate interests
- A claim against guarantors for any shortfall
If you see trouble coming, talk to your lender before the default, and bring your own lawyer and accountant into it. A forbearance agreement may buy time, but it often requires you to admit the debt, waive defences, and provide more security. Read those terms as carefully as you did the original loan.
A licensed insolvency trustee can also explain restructuring proposals, which may temporarily stay enforcement in some situations. The notice period under section 244 is short, so it is unwise to wait until the receiver arrives at your Brampton premises.
After the Loan Is Repaid
Paying off the balance does not clean up the record. Ask for a payout statement, written confirmation of discharge, the release of any guarantee, the return of any postdated cheques, and proper removal of the registrations. Discharges on the Personal Property Registry and on title do not always happen automatically, and an unreleased registration can complicate your next loan or the sale of your business. If the lender fails to act, the PPSA gives you a written demand process to force the discharge.
Getting the Documents Reviewed
A review costs far less than most enforcement disputes, and many of the helpful changes are modest: a cap on the guarantee, a carve-out for specific equipment, a realistic date for delivering financial statements, and notice before default. Our corporate law services include reviewing commercial contracts, and that extends to financing packages for businesses across Brampton and Peel. If you have already received a demand or a section 244 notice, time is short, and you should contact us or another lawyer promptly.